Unlimited Wants and Limited Resources

1

• Chapter 1
• Unlimited Wants and Limited Resources
• ? Scarcity ? Choices ? Optimal Choices
• ? Best use of limited resources
• Chapter 2
• What is Possible?
• What is Efficient?
• Economic Growth (Making more possible)
• Gains from Trade

2

• The Production Possibility Frontier (PPF)
• Gives combination of goods/services that can be
  produced with available resources and technology
• - Outside of PPF is Unattainable
• - Inside and On PPF is Attainable
• - Inside PPF is Inefficient (Why?)
• Production Efficiency
• - Cannot produce more of one good without
  producing less of some other good
• - Producing on the PPF gives production
  efficiency

3
Production Possibilities Frontier
Butter Guns Possibility
(tons) (units)

• A 0 and 15
• B 1 and 14
• C 2 and 12
• D 3 and 9
• E 4 and 5
• F 5 and 0

4
Production Possibility Frontier
15
Guns
Unattainable
10
5
0 1 2 3 4 5
Butter (tons)
5
Opportunity Cost and Marginal Cost
Increasing opportunity cost of butter ...
15
Guns
10
5
0 1 2 3 4 5
0 1 2 3 4 5
Butter (tons)
6

• Producing more of one good (along the PPF)
  requires producing less of the other good
• The amount of one good (e.g., guns) that must be
  given up in order to produce more of another good
  (e.g., butter) is the Opportunity Cost of the
  good (e.g., butter)
• The slope of the PPF gives opportunity cost
• As more of a good is produced the opportunity
  cost of the good increases (Why?)
• The Marginal Cost of a good is the opportunity
  cost of producing one more unit of that good

7

• Overall Efficiency
• Overall Efficiency requires not only production
  efficiency, but also that the best combination
  of goods and services is being produced. How to
  determine the best combination of goods and
  services?
• Consumer preferences
• - We measure the benefit to consumers by what
  they are willing to give up (or pay) for a good
• - The Marginal Benefit of a good is the amount
  that consumers are willing to pay to have one
  more unit of the good

8
Overall Efficiency requires that Marginal
Benefit equal Marginal Cost - If marginal
benefit is greater than marginal cost, then
producing more will increase net benefits
(benefits will increase more than costs) - If
marginal benefit is less than marginal cost, then
producing less will increase net benefits
(saved costs will exceed forgone benefits.
benefits will decrease by less than
costs) Hence, Overall Efficiency implies that
we cannot produce more of any good without giving
up another good we value more highly
9
Efficient Use of Resources
MC
5
4
3
Marginal cost and marginal benefit (guns per ton
of butter)
2
MB
1
0 1.5 2.5 3.5 5
Butter (tons)
10
Economic Growth ? Shift out in the PPF Sources
of Economic Growth 1) Technological Change 2)
Capital Investment - Physical capital - Human
capital
11
Economic Growth
c
10
8
If we produce 6 machines per period (B), then the
PPF rotates. We will be able to produce more
butter in the future.
Butter-making machines (per period)
B
6
4
2
PPF0
A
1
2
3
4 5 6 7
Butter (per period)
12

• Comparative Advantage and Gains from Trade
• Absolute Advantage
• Produce more with given inputs
• Comparative Advantage
• Produce at lower opportunity cost
• Comparative Advantage is key to gaining from
  trade Production should occur at lowest
  opportunity cost
• Example of Jim and Bobs Painting and Roofing

13
Suppose that in one day Jim can paint 2 houses
or roof 1 house Bob can paint 3 houses or roof 3
houses Who has comparative advantage in
what? Opportunity costs Jim 0.5 R for 1 P or
2 P for 1 R Bob 1 R for 1 P or 1 P for 1
R Jim has a lower opportunity cost of painting
and Bob has a lower opportunity cost of roofing ?
Jim has a comparative advantage in painting
and Bob has a comparative advantage in
roofing How does this compare to absolute
advantage?
14
Comparative Advantage and Gains from Trade Toms
and Nancys factories Tom If produce only
discs 4 units of discs and 0 units of cases -
If wants cases, must reduce disc 3 units for each
1 unit of cases Nancy If produce only cases 4
units of cases and 0 units of discs - If wants
discs, must reduce cases 3 units for each 1 unit
of discs
15
Comparative Advantage
5
Toms opportunity cost 1 disc costs 1/3 case,
and 1 case costs 3 discs
Cases (thousands)
4
4
Nancys opportunity cost 1 disc costs 3 cases,
and 1 case costs 1/3 disc
3
2
Trade line
1
1
1 2 3 4
Discs (thousands)
16
Thus Tom has a comparative advantage in the
production of discs and Nancy has a comparative
advantage in the production of cases (Why?) If
trade with each other, can get a better deal -
Suppose Tom trades 2 units of discs to Nancy for
2 units of cases - Both are better-off (both
now have 2 units of discs and 2 units of
cases) Another way to see the gains from trade
What would you do if you owned BOTH
factories?
17
Another Example of Comparative Advantage and the
Gains from Trade Bigville
Littleville Food Music
Food Music 500
0 100 0
400 50 80
40 300 100
60 80 200
150 40 120
100 200 20
160 0 250
0 200
18
The PPFs for Food and Music in Bigville and
Littleville
19
The PPFs for Food and Music in Bigville and
Littleville
Trade Line (at 1 for 1)